Markets Misjudge Europe's Inflation Shock: Contained Inflation or Excessive Policy?

Markets may be overpricing rate hikes from the European Central Bank and the Bank of England, according to ING economist James Smith. He argues that Europe's resilience in the face of the Iran War is due to contained inflation rather than excessively loose monetary policy.

Smith's research suggests that energy prices are contributing less than one quarter as much to eurozone inflation as they did during the 2022 crisis. Food inflation, wage-sensitive inflation, and corporate selling price expectations remain benign, making it difficult to justify several additional European rate hikes.

The hawkish case depends increasingly on a delayed pass-through that has yet to appear in the data. While indirect energy-sensitive inflation has barely moved, Smith acknowledges that this may still occur with a delay of approximately six months.